Mitsui & Co. Global Strategic Studies Institute Monthly Report November 2019 RETAILING IN AN ERA WITHOUT ONLINE/OFFLINE BOUNDARIES – JAPAN’S PATH TO OMO – Naohiro Hoshino Industrial Research Dept. I, Industrial Studies Div. Mitsui & Co. Global Strategic Studies Institute SUMMARY A merging of the online and offline spaces is attracting attention in the retail industry, and the food market is one of the stages on which this process is unfolding. In the operations of early online supermarkets and convenience stores, a number of problems came to the fore, including a discrepancy in the targeted user demographics, the profitability of delivery services, and inventory management, and a spate of retailers withdrew or shrunk the scale of their online services. After these experiences, EC companies and brick-and-mortar retailers have now started to pursue collaboration. While collaboration is expected to be effective in improving business efficiency and capturing customers to a certain extent, the key to realizing profitability will be the marketing mechanisms that combine sophisticated data acquired from online spaces and offline outlets, and the establishment of an infrastructure to that end. INTRODUCTION A new trend known as OMO (Online Merges with Offline) has recently been attracting attention in the retail industry. OMO refers to a marketing strategy designed to improve customer experience by providing an integrated service that transcends the boundary between the online and offline worlds. One reason for the heightened attention toward OMO recently is that companies that originated in the online world are also venturing into the offline (brick-and-mortar) realm, and they are becoming increasingly active. In China and the US, Alibaba and Amazon, both of whose roots are e-commerce (EC), have invested large sums of money in brick-and-mortar stores and logistics to obtain more customers with new services characterized by a fusion of the internet and the real world, and they are posing a threat to some physical store-based retailers. The strategy of these companies are to improve business efficiency and enhance customer experience and thereby to increase their customer base and revenue by taking advantage of the benefits and data that can only be acquired from operating both in online and offline realms. This is indeed the embodiment of OMO. While it is not as noticeable as in China and the US, a movement in line with the OMO trend is also emerging in Japan. This report reviews the trends to date in online supermarkets in Japan, centering on the food market where EC companies are particularly aggressive, and considers the possibilities and directions for future development as well as the issues involved. 1 Mitsui & Co. Global Strategic Studies Institute Monthly Report November 2019 1. OVERVIEW OF EC IN JAPAN 1-1 Low EC ratio of food products despite the large market scale In 2018, the scale of the retail EC (B2C) market in Japan was JPY9.3 trillion, representing an EC ratio of 6.22%1. Viewed by category, clothing and apparel items accounted for the largest share (JPY1.77 trillion), followed by food, drink, and alcoholic beverages (JPY1.69 trillion), home appliances, AV equipment, PCs and peripherals (JPY1.65 trillion), and household goods, furniture, and interior items (JPY1.61 trillion). In particular, the EC ratio of food products stands out as remarkably low at 2.64% (Fig. 1). However, since the food market itself is huge (approximately JPY64 trillion), food products still account for 18.2% of the retail EC market overall, despite having an EC ratio that low (Fig. 2). Fig. 1 Market scale & EC ratio in the retail sector by category （Trillions of yen） 70 Non-EC market 60 1.69 EC market 50 2.64% 1.61 40 1.21 30.80% 22.51% 30 1.77 1.65 0.61 0.23 0.22 20 12.96% 32.28% 5.80% 2.76% 40.79% 10 0 Note 1: The f igures in the chart show the EC market scale and EC ratio by category . Note 2: "Other categories" amounting to JPY308.3 billion hav e been omitted. Source: Prepared by MGSSI based on data f rom the "E-Commerce Market Surv ey " by the Ministry of Economy , Trade and Industry . Fig. 2 Percentage share of the retail EC market by category Others Clothing 27.7% 19.0% Retail EC market JPY9.3 tril. Food 18.2% （2018） Household goods Home 17.3% appliances 17.7% Source: Prepared by MGSSI based on data from the "E-Commerce Market Survey" by the Ministry of Economy, Trade and Industry 1 To be classed as EC, orders need to be placed over a computer network system. Accordingly, transactions in which only quotations are issued via a computer network system and actual orders are placed and received by an individual verbally, in writing, or by telephone, fax, or any similar means, are not classed as EC (“E-Commerce Market Survey,” Ministry of Economy Trade and Industry). 2 Mitsui & Co. Global Strategic Studies Institute Monthly Report November 2019 1-2 EC companies tapping into latent needs A low EC ratio for food products is not unique to Japan, but rather a common trend in markets worldwide. There are a number of possible reasons for this. First of all, food has a shorter shelf life than other products, and some items require the temperature to be controlled, making them unsuitable for long-term storage and transportation. Also, EC does not allow consumers to confirm actual products that are of varying quality and shape before purchasing. For these reasons, food has been regarded as a sector that is rather incompatible with EC. However, this is not to say that there is no EC need for food products. There are many people who cannot make frequent visits to retail stores for a variety of reasons. For example, elderly people who have difficulty driving or walking and people requiring nursing care are unable to go out easily, and working parents with children have the need to reduce the time and effort spent on shopping. In other words, as it deals with products that are closely related to consumers’ daily lives, the food market has huge potential for EC companies. Against this backdrop, companies such as the US’s Amazon and China’s Alibaba and JD.com have been focusing on exploring this area in recent years. A similar trend has started to appear in Japan as well, such as Amazon’s launch of its “Amazon Fresh” EC brand specializing in food products. 2. DEVELOPMENT OF FOOD EC IN JAPAN 2-1 The uphill battle of online supermarkets The history of food EC in Japan dates back to around 2000. When online supermarkets and convenience stores were launched back then, the idea was to add an online aspect at their offline locations. In other words, online business was introduced to supplement the core business of brick-and-mortar stores. With the use of a mechanism whereby goods were picked up from a physical store’s inventory or a distribution center and delivered to the customer’s home, consumers were basically able to purchase the same products that could be bought in physical stores, depending on their convenience. According to the people concerned, however, after the launch of services, a number of unexpected developments unfolded. Firstly, while it had originally been assumed that senior citizens and other people with poor shopping access use the services, once the service started, it turned out that younger generation usage was more considerable than expected. Responding to orders from a generation that places a high priority on specific delivery times and immediacy complicated delivery operations, delivery time slots filled up quickly, and it became difficult to meet the demand for specific time or same-day deliveries. Moreover, the delivery charges of several hundred yen were not paid for themselves, and the more orders were received, the more deficits increased. As such, online supermarkets and convenience stores have come to be recognized as non-profitable business models that hardly any company could turn a profit on a stand-alone basis. What’s more, the large number of online orders made inventory management difficult. When the unexpected volume of online orders came flooding in, some products went out of stock at physical stores to cover the online orders, resulting in a counterproductive situation for physical outlets. Because of these operational difficulties, many companies withdrew or shrunk their online services one after another. 2-2 Collaboration trend between EC companies and brick-and-mortar retailers These experiences, in turn, revealed that there surely is a demand for EC in the food sector, which is also growing. A new approach has now emerged to capture this demand and tackle the operational difficulties that became apparent with the online supermarkets at their early stage. The approach features business development through collaboration between EC companies and brick-and-mortar retailers. For example, the Seiyu supermarket chain has integrated its existing “Seiyu.com” service into the “Rakuten Seiyu Netsuper,” an online grocery delivery service, newly launched in collaboration with Japan’s EC giant Rakuten. In addition, the Life supermarket chain has begun selling fresh food and ready-made meals handled at its physical stores via the Prime Now service for Amazon Prime members. The Lawson convenience store chain has also started a 3 Mitsui & Co. Global Strategic Studies Institute Monthly Report November 2019 pilot program in collaboration with the food delivery company Uber Eats (Fig. 3). Fig. 3 Examples of collaboration between EC companies and brick-and-mortar retailers Seiyu/Rakuten Ito-Yokado/Askul Life/Amazon Lawson/Uber Eats (Rakuten Seiyu Netsuper) (IY Fresh) Uses both brick-and-mortar Uses stores as Prime Now Trial operation using the Tie-up with Askul's Lohaco Characteristics stores and dedicated logistics bases Uber Eats' UI service distribution centers Delivery in 2-hour time slots, Shortest delivery time 2 Next-day delivery in 1 hour Delivery shortest delivery time 4 Immediate delivery hours time slots hours Nov.